Inequality and the choice of the personal tax

It is possible to employ either income or expenditure as the base for personal taxation. A considerable literature has developed that investigates the relative efficiency of these bases. The answer is usually in favor of the expenditure tax since it encourages capital accumulation through the avoidance of the double taxation of saving. In contrast, the literature is almost silent on the relative equity of the two bases. We investigate the redistributive consequences of the choice in models with two sources of heterogeneity: skill in employment and lump-sum endowment. The Gini coefficient is used to measure the degreee of equity achieved by the tax bases in static and dynamic settings. Income taxes and expenditure taxes that generate equal welfare (or equal revenue) are compared. In the static economy the income tax leads to lower inequality except when skill and endowment are negatively correlated. Inequality is always lower with the income tax in the dynamic economy. These results support the choice of income as the base for personal taxation if reduction in inequality is a priority of policy.

This working paper is part of the Public Economics UK working paper series.